Securities are tradable financial instruments that comprise most assets bought and sold on financial markets. Securities play a key role in allowing investors to exchange their money for something that is considered to be a store of value and has a potential upside or pays dividends or interest. Bonds, stocks and exchange-traded funds (ETFs) are part of the broad definition that makes up fungible (exchangeable) financial securities.
In general, an entity - be it a government or a company - issues securities when it needs to raise funds.
These assets can be purchased by investors and can be held or traded. Of course, there are a variety of ways securities can be created and traded. First, we will look at the types of securities available.
What are the three types of securities?
Securities are divided into three categories: equity, debt and derivative securities. Below is a table explaining the differences.
|Example of an asset class||bonds||stocks||options, futures|
|Normal returns||fixed cash flow||dividends||derived from an underlying asset|
Debt securities, issued by companies or governments, are in essence financial loans. When someone purchases a bond (type of debt), they are lending money to the entity that issued the bond. In exchange, bond holders will receive a fixed or varied interest rate on the money they’ve lent. Given that these instruments pay regular and often fixed interest and the principal is returned at the time of maturity, they are called fixed income securities. The most common types include bonds, Treasury bills, certificates of deposit (CDs) and asset-backed securities (ABS).
Unlike with equity, if you hold the bond of a company your profit potential is more limited. However, there is more protection in case of bankruptcy, as debt holders are usually paid before equity holders.
Collateral and debt
A debt may be secured with collateral. What does this mean? If you have a mortgage (which is similar to a debt security), you have essentially two sets of collateral. The down payment that you give is the first collateral for the loan. The next one is the house you borrowed the money for.
When the entity that borrows the money cannot repay it, the collateral is given to the lender. In the case of a mortgage, you lose the house and the down payment.
Some of the most popular debt securities are corporate and government bonds. Of course, there are other kinds of bonds and we explain them in more detail in our article on the types of bonds.
In finance, equity securities typically refer to stocks. These types of securities give you ownership (equity) in the company that issued them. A company can issue a certain amount of capital stock. Within this, there are two types, common and preferred stock.
Owning stocks will give you rights like voting on company affairs or receiving dividends.
Not all profitable companies pay dividends though, some will re-invest their income to facilitate growth.
The price of the stock and your results are based on how well the company does and on investor opinion/sentiment, which usually determine the market price of a stock.
Finally, let's discuss derivatives. Grab your hats and hang on, this one's tough. A derivative is a contract based on something else, like a commodity, between two or more parties. It ‘derives' its value from something else, hence the name.
Originally, derivatives were mainly used to minimize risk. Now, they are often used to speculate on the prices of goods. There are different types of derivatives, the most common of which are futures and options. Other types of derivatives include swaps and forwards.
Let's take a closer look at options and futures to gain a better understanding of this complicated subject.
Options are of key importance for understanding how securities are traded on the market through speculation. The concept is difficult to grasp, so we will explain the call option in more detail. There are other options like the put option, and they are explained further in our article on options.
Say someone is confident that the price of a specific share, currently at $50, will rise in the future. Instead of buying the share, he could pay another party for an options contract. This options contract would stipulate that he will be able to buy let's say 100 shares before a specific date in the future for a specific price.
Of course, he has to pay a premium, which for the sake of the story, is $1/share. If the stock’s price does go up to $60 by the time of the expiry of the options contract, he would have earned $10 *100 = $1,000. Subtracting the premium, he still is up by $900. However, if the stock price goes down, he would not be obligated to purchase the shares and would be down $100.
Options can be much less risky than buying a share. Let's say that he did buy the share, and the price went down to $40. He would have lost 100*$10 = $1,000 rather than the $100 he paid for the contract.
Futures act slightly differently as they are focused on the contractual purchase of goods. Again, an example is the most efficient way to explain the idea.
Let’s take an example of a gold mine that wants to ‘hedge its exposure’ to gold prices. It means they want some protection in case gold prices (their product) go down.
What they could do is that they sell a future contract on gold. This allows them to fix the gold price they’ll receive in the future. On the other side of this trade, there’s someone who wants to speculate on the gold price rising.
Futures have many other aspects to them which make them a common tool for investors. A lot of factors go into the pricing like storage cost and the expiration date.
What are marketable and non-marketable securities?
Marketable and non-marketable securities are mainly differentiated in how liquid they are. What does liquid mean in financial terms? It denotes how easily an asset can be sold. Stocks in major companies like Apple and Amazon are very liquid as there is demand for them in the market. However, equity in a private company is restricted from sale.
Below is a chart explaining the differences between marketable and non-marketable securities.
Secondary market availability
You might be wondering what the differnece is between the secondary and the primary market. The names are rather counterintuitive as the primary market is not where most of the trading takes place. The primary market is where initial public offerings (IPOs) happen. This is when the company first sells its shares. If you would like to learn more about this read our article on investing in an IPO. The secondary market is where assets are traded after the initial sale and this is what most people refer to as the stock market.
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How can I invest in securities?
Buying and selling securities is by far the most common way of investing for beginners. The basic forms of debt and equity securities like bonds and shares are the most common types of investment.
In order to invest in securities. you will need a broker but there are a few other issues to settle before selecting a broker. First and foremost you need to draw up an investment plan. Here are a few things to include in your plan.
How much money do I have and what do I want to achieve?
It's helpful to think about where you stand in life from a financial perspective. Are you a student with a low income? Are you thinking about retirement or are you saving up for your child’s university fees? All of this will determine the amount of money you will end up investing and also the types of investments you will choose. No matter your strategy and goals, always remember that long-term gains trump short-term wins.
How much risk do I want to take?
Risk is an inherent part of investing but different types of investment carry different degrees of risks. For example, bonds have lower risk than stocks. An Exchange Traded Fund (ETF) trades based on a specific index. What do we mean by index? Say fifty companies are involved in car manufacturing. A specific ETF might invest in these companies and offer shares that are exposed to all of them. Therefore, when you buy a share in an ETF, you have a lower risk because they don’t rely on one company but rather the industry. We provide more information on ETFs here.
Select an asset class
Understanding asset classes can help you determine the optimal asset allocation of your portfolio. Asset classes tend not to be very closely correlated with each other, so having multiple asset classes in your portfolio is a good way to diversify. Real estate and gold may perform well during an economic downturn when there is a bear market for stocks. Spreading your investments across different asset classes may help you reduce your risk exposure.
If you are interested in learning more about asset classes and how they affect investing, take a peek at our article on investment asset classes.
Select a broker and open an account
Once you have decided your risk tolerance and have an idea where you want to put your moeny, you are ready to move on. Finding the right broker is extremely important as it can define how you will retire or how your investment journey will shape up. The selection is dayylingly wide and we encourage you to tread cautiously when choosing the righ broker.
Set up your payment method and invest
At most brokers, you can deposit money in your brokerage account via a bank transfer or a credit/debit card. Onece you have topped up your account, you are ready to start investing. Note that brokers differ in terms of how easily you can use their trading platforms. To compare the brokers around these factors, check our comparison table.
We at BrokerChooser are dedicated to helping you find the best broker for your investment needs. Below we will provide several brokers for securities that we recommend.
Finding the best brokers
At BrookerChooser, we analyze brokers based on a fully independent methodology consisting of hundreds of data points. Our analysis shows that the number one broker for trading stocks is Interactive Broker. If you are wondering about how we chose them, you can check out our methodology.
If you have never invested before, consult our best brokers for beginners list. Here, we make sure to give you the best and easiest brokers to make your way into trading securities.
Last but not least, we have our BrokerChooser Awards, which name the best of the best in a wide range of investent-related categories. This page is updated every year to keep you on top of the latest changes in the industry.
If none of these help you to find the right match, check out the find my broker tool, which has been developed to identify the best broker for your situation.
How are securities regulated?
Securities are regulated by different authorities in each country. Regulation is aimed at ensuring that the appropriate amount of information is provided to investors and that they enjoy certain levels of protection.
In the US, on the federal level, the primary securities regulator is the Securities and Exchange Commission (SEC). There are also self regulatory organizations (SRO) like the Financial Industry Regulatory Authority (FINRA) in the US. In the European Union, the primary regulatory authority is the European Securities and Market Authority (ESMA) while in the UK, financial markets are overseen by the Financial Conduct Auhtority (FCA).